After passing journal entries for events and transaction, posting them to ledgers and preparation of trial balance, the final step us to prepare final accounts. By final accounts, we mean manufacturing and trading account (only trading accounts in case of non-manufacturing entities), profit and loss accounts, and balance sheet and cash flow statements.
Other reports may also form part of final accounts depending upon nature of the business entity and requirements of the statute, for example, certain entities engaged in mining and natural resource abstraction, are required do include the statement of costing. Final accounts are popularly known as financial statements.
Financial statements are the systematically organised summary of all the ledger accounts heads presented in such a way that it gives full information about the financial position of the entity. The performance of the entity is judged based on income earned during the year. In financial accounting, profit is computed at the following two levels:-
- Gross profit
- Net Profit
For the purpose of computation of profit, Income Statement is prepared.
For the purpose of financial measurement position of the business enterprise and assets, liabilities and capital of the enterprise statement of financial position are prepared.
From the above explanation, one can conclude that final accounts are the next step after the
Preparation of trial balance is mainly divided into the following two parts:
- Income Statement
- Position Statement
Now we shall discuss in detail about these terms
1. Income Statement
How the amount of profit or loss is arrived at is disclosed in the Income Statement, prepared at the end of the year. The Income Statement finds out the net profit of the business after adjusting from the income earned during the year, all the expenditures of the business incurred in that particular year.
The various items of income and expenditure, which took place during the accounting period, are sorted therein and grouped under significant heads. The main objective of the Income Statement is to present the details of various items of income or expenditure, which are attributable to the making of the profit or loss.
Income Statement is sub-divided into the following two parts for a non-manufacturing concern:
(i) Trading account; and
(ii) Profit and Loss account
2. Position Statement
Position statement mainly comprises of Balance Sheet, which exhibits assets and liabilities of the business as at the close of the year. For proper information of the financial position of the business, sometimes additional statements are also prepared like the cash flow statement. These additional statements are prepared for a better understanding of the financial position by the users.
Preparation of Final Accounts
For determining the different aspects of transactions, a record should be kept in a proper manner and under different heads of account under which various items of income and expenditure should be accumulated, are stated below:
- Since the final statements of account are intended to show the profitability of the business and not that of its proprietors, all personal income and expenditure must be separated from business income and expenditure.
- A difference should be made between capital and revenue, both receipts and expenditure. Various types of income and expenditure should be classified under separate heads.
Assets should be recorded in the Balance Sheet at value arrived at on the basis at which these are valued in the previous year. Similarly, a provision for income and expenses which have accrued but not paid should be made by estimation or on the same basis as in the previous year.
- Every information considered the material for judging the profitability of the business or its financial position must be disclosed.
- Though the record of transactions should be maintained continuously, at the end of each accounting period, the transactions of the closing accounting period should be cut off from those of the succeeding period.
- It should be seen that only the effect of transactions, which has occurred before the close of the period of account, has been adjusted in the accounts of the year.
For example, when a sale of goods is to take place only after the purchaser has inspected the goods and the inspection had not been made before the close of the year, it should not be treated as a sale in the accounts of the year.